Dobson Dairies has a capital structure, which consists of 60 percent long-term d

Question

Dobson Dairies has a capital structure, which consists of 60 percent long-term debt and 40 percent common stock. The company’s CFO has obtained the following information:

-The firm's non-callable bonds mature in 15 years have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,150.00. The company’s tax rate is 35%. The company’s common stock is expected to pay a $3.00 dividend at year end, and the dividend is expected to grow at a constant rate of 7 percent a year. The common stock currently sells for $60 a share.

-Assume the firm will be able to use retained earnings to fund the equity portion of its capital budget.

What is the company’s weighted average cost of capital (WACC)?

Explanation / Answer

Answer: Calculation of WACC:

Ke=($3/$60)+7%

=12%

Kd=8%(1-0.35)

=5.2%

WACC=12%*0.40+5.2%*0.60

=4.8%+3.12%

=7.92%

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